The market breathed a heavy sigh of relief after two headwinds were essentially removed at the same time: election uncertainty was resolved, and hope emerged for a humanitarian resolution to the pandemic.
The pandemic, however, has brought about a significant amount of change, disruption, and loss, and we are not yet out of the woods. COVID-19 case rates continue to increase and are now past levels seen during the onset of the pandemic.1 Jobless claims in the US recently rose for two consecutive weeks for the first time since July.2 Yet, global equity markets are at record highs and the standard 60/40 portfolio is poised once again to post double-digit returns (up 10%).3
While the market breathed a sigh of relief in November, it may have to periodically hold its breath until the vaccines have been broadly administered and case rates fall precipitously alongside an uptick in more consistent economic growth. We are likely embarking on a period of recovery, but we will also still be adjusting to the continued evolution of corporate and consumer behaviors resulting from the crisis. For investors, the next few months may feel like staring at the end of a long tunnel, looking forward to being on the other side of an unimaginable mess.
Asset class ETF flows: Breaking records
With the market striking a decidedly risk-on tone, investors turned to ETFs to implement positions quickly and with precision. In November, ETFs gathered $94 billion of inflows—a record monthly high. This one-month record haul accounts for 21% of the full-year 2020 total, a figure that is now only $14 billion shy of 2017’s $456 billion annual record flow figure. Based on the five-year December average flow total of $50 billion, it seems 2020 is likely to set a record for full-year flows.
Given the strength in equity markets, equity ETFs were the main beneficiary as investors sought to deploy cash that may have been sitting on the sidelines. Equity ETFs saw inflows of $81 billion, as shown below, which was enough to overtake fixed income in terms of year-to-date flow totals.
Fixed income ETFs continued to benefit from a secular shift into the asset class, even though the tone switched from defense to offense quite significantly. The $17 billion accumulated in November marks the tenth month of inflows greater than $10 billion for bond ETFs. As a result, it is highly likely the category will surpass $200 billion in annual flows for the first time. A high estimate would be $208 billion of inflows by year-end (based on the one-year monthly flow average figure) with a low estimate of $201 billion (based on the five-year average monthly flow figure).
Geographical equity ETF flows: Focused on US exposures
With the dual headwinds of election uncertainty and vaccine timeline removed, investors targeted US-focused equity exposures to implement risk-on positions. US-focused equity ETFs saw $63 billion of inflows November, as shown below, a new monthly record that stands 21% ($11 billion) greater than the prior record set in January 2018.
Elsewhere, the $4 billion funneled into international single country ETFs represents a 5.5% increase from the segment’s start-of-month assets—the highest percentage figure of the categories shown below. Single-country flows were led by Chinese-focused ETFs, which made up 40% of the single-country total after tallying $1.7 billion on the month. The interest from investors in Chinese equities may have only just begun, as Biden’s more diplomatic and partnership-oriented approach—a reprieve from the Trump administration’s harsh rhetoric and punitive tariffs—is likely to make trade policy less confrontational and more predictable. This shift in tone and policy may compound China’s already strong growth profile.
Sector ETF flows: Driven by cyclicals
Investors are positioning for a cyclical recovery and are leveraging the precise nature of sector-focused ETFs to rotate into market segments more commonly associated with the recovery phase of the business cycle. Sector-focused equity ETFs registered $13 billion of inflows in November, as shown below. This is the largest figure since November 2016 and well above the five-year average monthly flow figure of $1.5 billion.
Post-election sector flows were driven by cyclical exposures. Financials led with more than $3 billion of inflows, pushing the segment’s year-to-date total into positive territory. The elevated interest in Financials is not surprising: As part of the recovery, we are likely to see a steeper yield curve driven by a move up in long-term rates, as short-term rates are expected to remain anchored to the zero bound thanks to accommodative Federal Reserve policies. Additionally, financial firms (like banks) have historically benefited from higher rates and a steeper curve—a result of their operational focus on borrowing short-term and lending to clients long-term. This relationship is evidenced by bank stocks’ 55% correlation to a move in 10-year interest rates.4
The $2 billion inflow into Industrials led on a relative basis, as the flows equated to 9.6% of the segment’s start-of-month assets. Three other cyclical sectors (Consumer Discretionary, Energy, and Materials) also had greater than $1 billion of inflows on the month. Health Care was the only “defensive” sector to have meaningful inflows. Overall, cyclical sectors outpaced defensives by $8 billion last month, and by $13 billion over the last three months. As shown below, this move reverses the downward trend from September when broader equity markets fell by more 3%, and looks vastly different from the spring period during the onset of the pandemic.
Thematic ETF flows: Clean energy leads in November
Funds focused on emerging trends in our economy took in $7 billion last month, raising the year-to-date total for these NextGen Trends funds to nearly $30 billion, representing a 69% organic growth rate in assets under management outside of any price appreciation. Notably, two-thirds of these funds are beating the S&P 500® Index this year, with an average return of 44%.5
Clean energy, a high-profile Biden-Harris administration agenda topic, had the greatest amount of flows, as shown below. Funds targeting broad-based innovation had the second-highest total and continue to lead for the year-to-date period.
Our daily routines have decidedly shifted. The world we knew in January is not the one we know now, and investors have sought to add exposures that offer access to the innovative firms at the forefront of our society’s transcendent change. Investors who have added positions understand the secular change—even as they also positioned for the cyclical recovery with traditional sectors.
I expect this to continue. While we are likely embarking on a period of recovery, we are still adjusting to the continued evolution of corporate and consumer behaviors resulting from the pandemic. As a result, investors should look to 2021 as neither a complete recovery nor a full evolution year, but rather a “recov-olution,”a transition that will require balancing the cyclical change of a recovery with the long-term ramifications of COVID-19’s future impact on our society.
Following the onset of the pandemic, flows into thematic funds have accelerated, as shown below. The long-term nature of the secular societal sea change and the potential these firms offer for future growth may underpin the interest in these strategies.
Seeking additional balance
Investors are facing prospects for an uneven recovery potentially featuring run-ups in cyclical markets (i.e., value) and questions around the sustainability of growth that may lead to further gains for higher-quality stocks. As such, a portfolio’s core should reflect these two distinct style traits, creating additional balance that allows for more specific positioning elsewhere for potential cyclical changes (banks, value, small-cap) and secular changes (broad innovation, clean energy, and intelligent infrastructure).
1 “Covid-19: Pandemic Shatters More Records in U.S., as States and Cities Tighten Restrictions”, New York Times, 11/15/2020
2 "U.S. Recovery More Tenuous as Jobless Claims Rise, Incomes Fall", Bloomberg, 11/25/2020
3 Based on the total return for the MSCI ACWI IMI Index and the Bloomberg Barclays US Aggregate Bond Index
4 The S&P Banking Select Industry Index has a 0.55 correlation to the US 10-year yield from 11/30/2015 to 11/30/2020
5 Bloomberg Finance L.P. as of 11/30/2020, based on calculations by SPDR Americas Research
Bloomberg Barclays US Aggregate Bond Index: A benchmark that provides a measure of the performance of the US dollar denominated investment grade bond market, which includes investment grade government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the US.
MSCI ACWI IMI Index: a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. It covers c.9000 securities across large, mid and small cap size segments and consists of c.45 country indices, of which approximately half are developed and half are emerging markets.
S&P 500 Index: A stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
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